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Friday, 20 April 2012

MANAMA: Greater co-operation, rather than competition, between the Middle East's Islamic financial institutions is necessary if the sector is to provide a real alternative to the conventional, international banks operating in the region.

That was the claim by Noor Islamic Bank chief executive Hussain Al Qemzi who was speaking at the Middle East Islamic Finance and Investment Conference in Dubai.

He said regional Islamic banks do not have the financial punch to challenge their larger competitors from the US, Europe and the Far East.

"If we are to challenge the conventional banks' entrenched position in international financial deals, we must develop the capacity to structure multi-currency and cross-border transactions and to build scale," he said.

"To do that, we need to build deeper relationships between the key markets and between individual banks. Only then, will we be better placed to compete on a global scale.

"I have been asked many times what is it that international banks do well? The answer is simple. They leverage the relationships they have with banks they know well. Why can't Islamic banks do this?"

"At Noor, it is a model we have employed successfully in Turkey, where we have worked closely with other banks to lead manage and arrange more than $2 billion of capital in finance market deals.

"More than 55 institutions from 15 countries, across Europe, Asia, Africa and the Middle East, have participated. If it can be done in Turkey, it can be done anywhere," he added.

He also urged the Islamic finance industry to work together to overcome differences in interpretation of Sharia compliance and to develop new and innovative products and services, which would allow Islamic banks to offer a true alternative to conventional banking.

"As we acknowledge our differences in the interpretation of Sharia principles, we must also acknowledge that these differences cannot be used as an excuse for our industry not to engage in open and free business," Mr Al Qemzi said.

"The time has come for us to stop focusing on our differences as reasons for not doing business.

"It is time to talk about how Islamic finance can contribute to long-term inclusive, equitable and sustainable economic growth not just here, in the Middle East, but in every country across the globe.

With Britain now in talks to sell part of the government’s 82 percent stake in the Royal Bank of Scotland to Abu Dhabi sovereign-wealth funds, the Islamic world’s growing financial clout is once again on display. That clout also poses a systemic challenge to the dominant way that finance is now practiced around the world.

From humble beginnings in the 1990’s, Islamic finance has become a trillion-dollar industry. The market consensus is that Islamic finance has a bright future, owing to favourable demographics and rising incomes in Muslim communities.

Despite scepticism regarding accommodation between Islamic and global finance, leading banks are buying Islamic bonds and forming subsidiaries specifically to conduct Islamic finance. Special laws have been enacted in non-Muslim financial centres – London, Singapore, and Hong Kong – to facilitate the operation of Islamic banks and associated financial institutions.

How should these developments be viewed from the perspective of Western finance and mainstream economic analysis? Does Islamic finance really constitute a viable alternative financial system?

The very fact that such a question is asked nowadays is significant. Not so long ago, Islamic finance was superficially dubbed a zero-interest-rate system that would lead to inadequate and inefficient resource mobilization and utilization. Ironically, mainstream central bankers today routinely use precisely such policies when pursuing massive “quantitative easing.”

There are two central precepts of Islamic finance: absolute prohibition on charging interest on financial transactions, and high moral standards on the part of lenders and borrowers. Interestingly, the best economic rationale for a zero-interest-rate system is provided in John Maynard Keynes’s The General Theory:

“Provisions against usury are amongst the most ancient economic practices of which we have record….In a world, therefore, which no one reckoned to be safe, it was almost inevitable that the rate of interest, unless it was curbed by every instrument at the disposal of society, would rise too high to permit of an adequate inducement to invest.

Keynes suggested that only a very low or zero interest rate could ensure continuous full employment and distributional equity. Keynes’s endorsement of such a policy does not necessarily make it right, but his analysis does suggest that it should be regarded as a serious proposition.

Importantly, although interest is prohibited under Islamic finance, profit is not; the latter is derived from various arrangements that combine finance and enterprise. In essence, this is a profit-sharing and risk-sharing system that is based entirely on equity finance.

Islamic finance thus contrasts with the current dominant system based on interest-bearing debt, in which risks are theoretically transferred to debt holders, but in practice are socialized during crises. Other things being equal, most economists will agree that debt finance leads to greater instability than equity finance.

It follows from the second major tenet of Islamic finance that if people adhered strictly to its ethical requirements, there would be fewer moral-hazard problems in Islamic banking. Moral hazard exists in all systems in which the state ultimately absorbs the risks of private citizens.

But, whether any particular system is efficient in avoiding moral hazard is a matter of practice, rather than of theory. Many would agree that, historically, Christian morality played an important role in the rise of Western capitalism. Secular capitalism, however, has experienced an erosion of values, whereby the financial sector has put its own interests above those of the rest of society. If the ethical values in Islamic finance – grounded in sharia religious law – can further deter moral hazard and the abuse of fiduciary duties by financial institutions, Islamic finance could prove to be a serious alternative to current models of derivative finance.

Moreover, the basic tenets of Islamic finance force us to re-think the ethical basis of modern monetary arrangements, which have evolved into a global reserve-currency system founded on fiat money. In the past, gold had been the anchor of monetary stability and financial discipline, even if it was deflationary.

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